Supervision system inspires 'cavalier' bankers

One of the world's top financial regulators has launched a scathing attack on the global system of banking supervision.

Hans Hoogervorst, who chairs the financial services authority in the Netherlands, says the Basel Two accord, which underpins global banking regulation, helps promote a cavalier attitude among banks around the world.

Mr Hoogervorst warns the Basel criteria are worth little more than the word of credit ratings agencies, which have come under fire in the wake of the global financial crisis.

The former Dutch health minister had a captive A-list audience of regulators, market players and high-powered observers attending a three-day summer school hosted by ASIC in Melbourne on Monday.

"The Basel criteria may not have been much more reliable than the triple-A ratings of the much vilified credit rating agencies," he said.

"Looking back, it is obvious that the pre-crisis financial system was an accident waiting to happen."

Mr Hoogervorst says Basel Two promoted the rapid growth of leverage in the banking system while less attention was focused on liquidity or cash on banking sheets.

He says the Basel committee is subject to intense lobbying from the banking industry and politicians and proposals to fix the system are often watered down.

He believes banks and regulators were so fixated on Basel that they did not see the symptoms of a financial system about to implode.

"Obviously it was sheer madness to allow the banks to operate on the flimsiest of capital margins," Mr Hoogervorst said.

"Many bankers and prudential regulators told me recently that they were so much focused on the Basel ratios that they simply did not see the leverage building up in the system.

"They promoted a cavalier attitude in the market with even presumably sophisticated market participants forgetting to look behind the numbers."

Among those to hear Mr Hoogervorst's comments was Reserve Bank governor Glenn Stevens, who admitted that while Australia's banking system was highly regulated and well capitalised, there were some lessons to be learned from the European experience.

"It probably wouldn't hurt for there to be a little bit more capital and more attention to liquidity and more attention paid to the possibility that important funding markets that banks rely on can seize up and that's got to be remembered when they're managing their businesses," Mr Stevens said.

He said while Australia had avoided the global downturn through good management rather than good luck, he delivered a warning.

"Please continue to be more conservative than the rest of the world, and secondly prepare for a very difficult economic time which you will not be able to continue to escape," Mr Hoogervorst said.

In response to a question about the Greek sovereign debt crisis, Mr Hoogervorst pointed to a second wave of economic pain brewing in Europe, a wave that could neutralise the economic shield being provided to Australia by China.

"This is going to take a tremendous toll on the world's economy for a long time to come and Australia will not be able to escape that, because I don't think Asia, China can completely compensate for all the problems in the western world," he said.

Mr Stevens is confident rather than complacent and acknowledges the dire state of northern hemisphere economies that are sinking under debt.

"These challenges are immense and the challenge for those countries is to articulate a short-term path that charts a path back to long-run sustainability. That is going to be very difficult," he said.